Declining Federal Aid: Re-thinking Property Taxes as Localities Flock to User Fees and Sales Taxes

It is no secret that state and local governments have faced increased pressure to provide their own sources of revenue as federal aid has decreased and mandates to provide certain services have increased. Federal aid to state and local governments declined rapidly between 1977 and 1987.

At the same time, property taxes, once the bread and butter of local governments, have also been on the decline. This has led to major funding difficulties within localities in states such as Oregon where there are harsh and complex limitations on property tax rates. In the absence of political will to raise property taxes, local governments have filled some of these funding gaps with user fees and sales taxes, which tend to be more regressive than property taxes and the federal redistributions that they replace.

            In Oregon, political pressure to keep property tax increases in check resulted in the passage of state constitutional measures 5 and 50 in 1990 and 1997, respectively. Collectively, these laws both limit the rate at which property tax revenues can be levied and the rate at which the assessed value of a property may increase each year. Because maximum tax rates in Oregon are based on a percentage of the market value of properties rather than on the assessed value, market fluctuations can severely limit government revenues. This document from the state of Oregon includes a nice history of property tax law in the state. Oregon also relies heavily on natural resource revenues to fund education and other services. Due to a combination of market fluctuations and decreasing distribution of tax dollars from federally owned forest land, the state has experienced rapidly declining timber revenues over the last several years. As localities in Oregon struggle to fund vital services such as education, public safety, and fire protection, some have desired to raise additional revenue through property tax increases but have been unable to do so because of the nature of the state-imposed limitations. For example, the Tualatin Valley Fire & Rescue recognizes that the inability to raise property taxes beyond the limits imposed by measures 5 and 50 represents a serious threat to their future ability to adequately respond to the needs of their service area because they rely heavily on property tax revenue. As federal aid to state governments continues to decline or states experience revenue losses due to market fluctuations, leadership should be exercised to make it possible for local governments to increase revenues from existing sources or tap into additional revenue streams.

            Many local governments have dealt with declining revenue by resorting to more regressive revenue sources such as sales taxes and user fees. While both of these revenue streams are relatively politically feasible, both may be more regressive than property and income taxes. User fees such as impact fees on new development have risen in popularity because they provide an opportunity to “export” taxes to new residents who are moving to a locality. While impact fees are relatively efficient, they may discourage the provision of housing for lower income populations because developers have a more difficult time passing on the cost of the fee to lower income home buyers and renters who do not have the same ability to pay as their wealthier neighbors do. Impact fees (and user fees in general) are further regressive in that they are not easily redistributed. Because a “rational nexus” is required between the fee and the use of the fee, it is not always possible to levy a fee on wealthy home-buyers and use it to benefit lower income neighborhoods.

            If declining federal aid to local governments continues, state elected officials will need to exercise leadership in crafting policies that address local revenue shortfalls while making it easy for localities to utilize progressive revenue sources such as property taxes. From an equity standpoint, decreases in redistributions from federal income taxes and property taxes should not be replaced by an equivalent sales tax or user fees because these revenue sources are more regressive than those that they replace. Furthermore, care should be exercised in crafting limitations on revenues from property or natural resource taxes that vary widely with economic fluctuations. Such policies are short sighted, encourage increases in regressive revenue sources, and limit the autonomy of state and local governments as more and more is being asked of them.